How Regulation is Destroying American Jobs

How Regulation is Destroying American Jobs

During the 1980s, America's ability to create jobs was the envy
of the world. No longer. The American job-generating machine has
ground to a halt, and regulation deserves much of the blame. The
regulatory burden on U.S. firms relaxed through most of the 1980s,
and private-sector employment grew by 19 million jobs. Most of
these new jobs were created by small businesses, which are most
sensitive to regulatory costs. Over the last four years, however,
the regulatory burden has grown substantially (especially for small
and medium-sized businesses), and the private sector has lost
nearly two million jobs since early 1990.

While government red tape is a costly frustration to American
business, few business owners -- or even government policy makers
-- appreciate the full impact of regulation. Among the little-known
facts:

Government regulation costs at least $8,000 per household, and
may reduce national output by as much as $1.1 trillion per
year.

Unnecessary and inefficient regulation at the federal, state,
and local levels is now costing the American people somewhere
between $810 billion and $1.7 trillion per year -- even after
taking account of the benefits of regulation -- or between $8,400
and $17,100 per year per household. (Nancy A. Bord and William G.
Laffer III, "George Bush's Hidden Tax: The Explosion in
Regulation," Heritage Foundation Backgrounder No. 905, July 10,
1992, p. 19. Regulations may be treated as "unnecessary" if (1) the
costs they impose exceed the benefits they produce, or (2) even
though they produce benefits that may exceed costs, they do so in
an unnecessarily costly manner because of an inefficient method or
approach. The basis for the distinction between necessary and
unnecessary regulations is discussed further in footnote 15 below.
) A major portion of this cost consists of the additional goods and
services that the American economy could have been producing today
but is not because of over two decades of slower growth due to
excessive and inefficient regulation. The value of this foregone
output is somewhere between $450 billion and $1.1 trillion per
year. (Ibid.)

Regulation reduces total U.S. employment by at least three
million jobs.

Another heavy cost of regulation is reduced employment
opportunities for Americans. This toll is not usually apparent,
because in most instances regulation merely leads to a slower
growth in employment rather than to visible loss in existing jobs.
Nonetheless, even by a fairly conservative estimate, there are at
least three million fewer jobs in the American economy today than
would have existed if the growth of regulation over the last twenty
years had been slower and regulations more efficiently designed.
(Footnote 17 below explains how this figure was calculated.)

Many regulations directly increase the cost of employing workers
and thereby act like a hidden tax on job creation and employment.
Among such regulations are minimum wage laws and federal labor
laws. These regulations place especially heavy burdens on small
businesses, the primary engines of job creation. And exempting
smaller businesses from regulations generally does not solve the
problem. Instead it simply creates a "Catch 22" situation in which
growing small firms are penalized by an increase in the number of
regulations they became subject to.

Officials currently face no explicit requirement to consider
employment effects as they develop new rules. Nor do lawmakers.
Even when the agencies or congressional committees do consider the
employment effects of proposed rules or regulatory legislation,
policy makers often do so in ways that are simplistic or that rely
on faulty assumptions and models. The methodologies used vary from
agency to agency, and from regulation to regulation even within
agencies. Moreover, nowhere in the entire federal regulatory
process does anyone consider the cumulative effects of existing
regulations, or the possible combined effects of new and existing
regulations.

To deal with the mounting employment costs of regulation,
Congress and the Clinton Administration should institute several
urgent reforms. Among the most important:

Reform #1: President Clinton should issue an executive order
requiring explicit consideration of the employment effects of all
new regulations.

Reform #2: Congress should extend the same requirement to all
"independent" regulatory agencies that are outside the executive
branch.

Reform #3: Congress should establish a federal regulatory
budget. Such a budget means that a maximum total regulatory burden
that government could impose on the economy -- or regulatory budget
-- would be established. Whenever an agency planned to add a new
regulation that would exceed the budget, it would be required to
repeal or modify some other regulation so that the total burden
imposed on the economy by federal regulation would not be
increased. Alternatively, the government would have to arrange an
offsetting reduction from another agency.

Reform #4: Congress should require the expected employment
effects of all proposed regulations to be published in the Federal
Register; even before such a requirement is imposed, executive and
independent agencies should voluntarily publish the expected
employment effects of proposed regulations. This would permit the
American people to know the expected magnitude of any job losses
due to a new rule before it takes effect. Americans then could let
officials and lawmakers know if they felt the benefits of the
proposed rule were worth the job losses.

Enactment of these four reforms would reduce substantially the
cost that federal regulations impose on the economy, while
preserving or even increasing the benefits that regulations
sometimes can provide. In particular, they would reduce the toll on
employment and wages that the well-meaning pursuit of worthy ends
often takes. A clean environment and safe and discrimination-free
workplaces can be achieved without depriving three million or more
Americans of jobs.

How Regulation Kills Jobs

Between January 1, 1983, and March 31, 1990, private-sector
employment in the U.S. economy grew by some 19 million jobs, rising
from 72.8 million jobs in December 1982, to 91.8 million jobs in
March 1990. However, over the next two years the private sector
lost nearly 2.2 million jobs, reaching a low of just over 89.6
million jobs in January 1992. The number of private-sector jobs has
recovered only slightly since then, rising to 90.1 million jobs as
of January 1993. (Source: U.S. Department of Labor, Bureau of Labor
Statistics (BLS) ("establishment data," based on a monthly survey
of employers, seasonally adjusted). These figures do not include
agricultural employment or employment by federal, state, or local
governments. Using BLS's figures for total civilian employment
("household data," based on household interviews conducted monthly
by the Bureau of the Census, seasonally adjusted), including
agricultural employment and non-military government employment, the
relevant employment figures are 99 million jobs in December 1982,
118.3 million jobs in May 1990, 116.5 million jobs in August 1991,
and 118 million jobs as of January 1993.)

What accounts for the difference between the two periods? In
particular, what caused employment to start rising in January 1983,
and what caused it to begin to fall in April 1990? To be sure,
there are many factors that affect employment levels, including
taxation. Tax rates were reduced significantly in 1983, but
increased somewhat in 1990. (See Daniel J. Mitchell, "An Action
Plan to Create Jobs," Heritage Foundation Memo to President-Elect
Clinton No. 1, December 14, 1992, pp. 4-5. The tax cuts that were
enacted in 1981 did not take full effect until January 1983.
Although the 1990 tax increases were not signed into law until
November 1990, President Bush renounced his "no new taxes" pledge
and indicated his willingness to agree to a tax increase in June
1990.)But there is considerable evidence to suggest that changes in
the total cost of federal and state regulation also played a major
role, especially in the downturn that occurred in 1990.

As the graph on the following page indicates, regulatory costs
generally were declining during the period of private-sector
employment growth. The period of decline and stagnation, by
contrast, started shortly after regulatory costs started to rise
again. Moreover, as the graph on page 5 shows, there was a very
close negative correlation between the number of federal regulators
and private-sector employment. Fewer regulators coincided with an
increase in job growth; an increase in regulators with a decline in
job growth and even a decline in jobs.

Firms base their decisions to employ
workers . .. .. in part, on the total cost to the firm of employing
workers. . .. .. All else equal, the greater the cost to the firm
of employing each worker, the less workers the firm will employ.
Conversely, the lower the cost per worker, the more workers the
firm will hire. (Arthur B. Laffer, "Supply-Side Economics,"
Financial Analysts Journal, September/October 1981, pp.
32-33.)

In a world without taxes or regulations, the cost to employers
of hiring an additional hour of labor services and the benefit to a
worker of working an additional hour would be the same. Taxes and
regulations raise the cost to employers above the reward received
by the employee. These government-mandated costs include such items
as unemployment and disability insurance, government paperwork
requirements, and the cost of lawyers to advise firms on how to
comply with the rules. While some of these government-imposed costs
do provide a benefit to the employee, many of them do not.

The difference between what it costs a firm to employ a worker
and the net benefit the worker receives is commonly referred to by
economists as the "regulation and tax wedge." Any increase in the
wedge, whether caused by regulations or by taxes, will tend to
raise the cost to employers of hiring an additional employee,
thereby reducing the demand for labor, and reduce the net wages and
benefits workers receive, thereby reducing the supply of labor as
well. Thus, the basic laws of economics indicate that if regulatory
burdens rise (and tax burdens do not fall by an equal or greater
amount), employment and wages will fall.

The Direct and Indirect Effects of
Regulation

Some regulations have a direct and immediate impact on wages or
employment. The minimum wage law and federal labor laws, for
example, tend to increase the cost of employing workers and thereby
decrease wages or employment, and sometimes both. Other regulations
affect wages and employment indirectly, but just as significantly.
Banking and environmental regulations, for example, have a
considerable negative effect on the overall level of economic
activity. And when output slows, employment usually slows with
it.

More often than not, the effects of regulation on employment are
hidden by other factors, such as tax policy or general economic
changes. But in other instances, the impact on jobs is very clear.
Example: The federal government's efforts to protect the northern
spotted owl, under the Endangered Species Act and other related
laws, means millions of acres of land in Washington, Oregon, and
northern California have been closed to logging operations. Tens of
thousands of loggers have lost or will lose their jobs because of
these regulations, and thousands more jobs have been lost in
communities dependent on logging as the principal industry.

Example: California has increased regulation sharply over the
last two years, driving businesses and jobs from the state.
California has lost approximately 700,000 jobs since May 1990.
(George F. Will, "Can California Compete?" The Washington Post,
September 27, 1992, p. C7.) Indeed, for the first time in nearly
twenty years, more people are leaving California than arriving.
("Californians leaving state in record numbers," The Washington
Times, September 4, 1992, p. A2.) While California's job exodus of
course is due to many factors, including higher taxes, several
studies and surveys have concluded that regulations -- especially
onerous new environmental regulations -- are the principal factor
driving businesses' decisions to leave the state. (The most
important of these studies is California's Jobs and Future (April
23, 1992), a detailed report prepared by the Council on California
Competitiveness, led by Peter Ueberroth, the former baseball
commissioner and organizer of the 1984 Olympic Games in Los
Angeles. Another is Mark Baldassare and Associates, "Department of
Commerce Survey of California Manufacturers" (Sacramento:
California Department of Commerce, Office of Business Development,
December 13, 1989). Two additional surveys are cited in Philip K.
Verleger Jr., "Clean Air Regulation and the L.A. Riots," The Wall
Street Journal, May 19, 1992, p. A14.)

Why the Regulatory Cost is Usually Hidden

Still, cases in which regulation can be clearly identified as
the culprit for specific job losses are the exception rather than
the rule. There are several reasons why there is rarely a smoking
gun: Businesses usually base their decisions on such matters as
whether or where to build a new plant, and how many people they
will hire, on a variety of considerations. It is rarely clear which
consideration was decisive.

The result of regulation often is not a cut in wages or
employment levels, but simply slower growth over time. Jobs not
created are much less visible than layoffs.

Regulation in one part of the economy can have an impact in
other areas. For example, a recent study by economists Michael
Hazilla of American University and Raymond Kopp of Resources for
the Future, a Washington, D.C.-based research group specializing in
environmental issues, found that environmental regulations had
reduced employment in the finance, insurance, and real estate
industries by 2.64 percent as of 1990. (Michael Hazilla and Raymond
J. Kopp, "Social Cost of Environmental Quality Regulations: A
General Equilibrium Analysis," Journal of Political Economy, Vol.
98, No. 4 (1990), p. 869.) This occurred despite the fact that
these industries produce no pollution themselves and thus did not
incur the direct cost of pollution abatement equipment. Hazilla and
Kopp found that all sectors of the economy are affected by
environmental regulations, because such regulations cause the cost
of inputs to the production process such as labor, raw materials,
and electricity to rise, and cause savings, investment and capital
formation to fall.

Unfortunately for workers, the indirect causal links whose
effects Hazilla and Kopp attempted to measure are invisible to most
observers. Nonetheless, Hazilla and Kopp found the employment
effects of environmental regulation for the economy as a whole to
be substantial. By their estimates, environmental regulations alone
had by 1990 reduced the overall employment level by 1.18 percent.
(Ibid., p. 867.) This would mean between 1.1 million and 1.4
million fewer jobs than would have existed without environmental
regulation. (The average number of Americans employed in 1990 was
between 91.5 million and 117.9 million, depending on which BLS data
series one uses. 91.5 million x 1.18% = 1.1 million. 117.9 million
x 1.18% = 1.4 million. Of course, the number of jobs eliminated by
environmental regulation might be smaller if some of the 1.18
percent reduction in labor supply were simply due to people working
fewer hours in existing jobs.) Moreover, environmental regulation
significantly altered the distribution of labor employment across
the economy. Although a few sectors, such as the natural gas
industry and the wholesale and retail trade sectors, experienced
modest increases in employment, most sectors experienced
reductions.

The Total Cost to the Economy

Most studies analyzing the cost of regulation examine only
direct compliance expenditures. They do not consider the indirect
effects of regulation on output and employment. But some other
studies, such as that by Hazilla and Kopp, suggest that the
indirect effects may be as large as or even significantly larger
than the direct compliance costs, at least in the case of
environmental regulations. (Another such study, with similar
results, was done by economists Dale Jorgenson of Harvard
University and Peter Wilcoxen of the University of Texas. See Dale
W. Jorgenson and Peter J. Wilcoxen, "Environmental Regulation and
U.S. Economic Growth," RAND Journal of Economics, Vol. 21, No. 2
(Summer 1990), pp. 314-40.) The reason for this is that reductions
in investment due to regulation have cumulative effects over time
on output and employment.

The most widely cited estimates of the combined cost of all
federal regulations put the figure between $595 billion and $667
billion per year for 1992, measured in 1991 dollars. (Thomas D.
Hopkins, Cost of Regulation, Rochester Institute of Technology
Public Policy Working Paper (December 1991); Robert W. Hahn and
John A. Hird, "The Costs and Benefits of Regulation: Review and
Synthesis," Yale Journal on Regulation, Vol. 8, No. 1 (Winter
1991), pp. 233-278. The figures in the text are arrived at by
taking Hopkins's estimate of the total cost of regulation as of
1992, substituting Hahn's and Hird's original estimate of the gross
cost of economic regulation for the figure Hopkins used (which was
a modified version of Hahn's and Hird's estimate), substituting
Hopkins's updated but as yet unpublished figure for the federal
paperwork burden, and converting the new total from 1988 to 1991
dollars.) However, these estimates do not take any account of the
indirect effects of regulation on output and employment. A recent
study by Nancy Bord and William Laffer, of The Heritage Foundation,
attempted to estimate the indirect effects of all regulations --
state as well as federal -- by extrapolating from the results of
other studies, such as that of Hazilla and Kopp. Bord and Laffer
calculate that, in the absence of all unnecessary regulatory costs,
(Insofar as some types of regulation -- environmental regulation in
particular -- produce benefits as well as costs, one may not simply
assume that all of the costs of regulation can be eliminated.
However, even where existing regulations may produce benefits that
exceed costs, it often appears that the same or even greater
benefits could be obtained at a significantly lower cost by using
better-designed, more efficient forms of regulation. Consequently,
in calculating the foregoing figures, wherever a regulation
appeared to produce net benefits, no cost was counted except the
difference (if any) between the actual cost imposed by the
regulation in question and the lower cost that would be incurred
under a more efficient regulatory scheme.) annual gross domestic
product (GDP) would exceed its current level of $5.672 trillion as
of 1991 by at least some $450 billion, and possibly by as much as
$1.1 trillion. (Bord and Laffer, op. cit., p. 19. Bord and Laffer
used a very wide range of estimates of the ratio of indirect costs
to direct costs because of the inherent uncertainty involved in
estimating how much output is not produced. That is why their lower
and upper bounds are so far apart. )This additional output would
mean the existence of several million additional jobs. Even a
conservative estimate would put the figure at well over three
million jobs. (Based on the ratio of 1991 GDP to average
private-sector employment in 1991, the production of an additional
$450 billion to $1.1 trillion in annual GDP would mean the creation
of an additional 7.2 million to 19.2 million jobs, depending on
which figure is used for private-sector employment. However,
because much of the additional GDP would have come from increased
productivity, rather than increased employment, the actual job
growth figures would likely be much smaller. Assuming that half of
any increase in annual GDP came from increased employment, the
additional jobs that would have been created in the absence of all
unnecessary regulatory costs would number between 3.6 million and
9.6 million.)

Examples of Job-Destroying Regulations

As noted earlier, some regulations directly increase the cost of
employing workers and thereby act like a tax on job creation and
employment. Three examples show in practical terms how this
happens.

Example #1: Minimum Wage Legislation

It is now almost universally accepted that minimum wage laws
reduce the employment of low-skilled workers whose productivity
simply is not worth what the employers are required by law to pay.
(See, e.g., Simon Rottenberg, ed., The Economics of Legal Minimum
Wages (Washington, D.C.: American Enterprise Institute, 1981).) The
only major disagreement today is over the degree of employment
reductions caused by the minimum wage requirement. (Some studies
note, for example, that while the minimum wage law reduces
employment of low-skilled workers, it may increase employment of
medium-skilled workers who, to some extent, can be used in lieu of
the low-skilled workers whose labor the minimum wage renders too
expensive. However, the increase in employment of medium-skilled
workers is never enough to fully offset the decrease in employment
of low-skilled workers.)

For the nine years running from January 1981 through March 1990,
the federal minimum wage remained fixed at $3.35 per hour. Because
of inflation, however, the real value of the minimum wage -- and
therefore the real cost to businesses of employing less-skilled
workers -- declined. Not surprisingly, the percentage of teenagers
with jobs climbed from 41 percent to over 48 percent over the same
period. (Alan Reynolds, "Cruel Costs of the 1991 Minimum Wage," The
Wall Street Journal, July 7, 1992, p. A14.)

Congress decided in 1989 to increase the federal minimum wage to
$3.80 per hour as of April 1, 1990, and to $4.25 per hour as of
April 1, 1991. Again, not surprisingly, teenage employment fell
immediately after each of these increases. Just four months after
the 1990 increase, for instance, the percentage of teenagers with
jobs had fallen from over 48 percent to less than 43 percent,
undoing most of the previous nine years' improvement. (Ibid.)

In total, the federal minimum wage rose by 27 percent, and
teenage employment fell by 11 percent. (Ibid.)The 1990 and 1991
minimum wage increases made it harder for teenage workers to get
summer and Christmas vacation jobs. The hikes made it harder for
young adults with little education, skill, or experience to obtain
their first full-time entry-level jobs. These are the jobs where
they would acquire the training, experience, and work habits that
eventually would make their labor worth more than the legal
minimum. And the increases in the minimum wage made it harder for
unskilled housewives trying to supplement their family's income
while their children are in school to obtain part-time work.

Calculations by economists Lowell Gallaway and Richard Vedder of
Ohio University show that the total cost to a business for each
worker hired and for each hour worked rose sharply after each of
these increases in the minimum wage, but especially after the first
-- which was the larger of the two increases in percentage terms.
(Lowell Gallaway and Richard Vedder, "Why Johnny Can't Work: The
Causes of Unemployment," Policy Review, Fall 1992, p. 29.)
Furthermore, calculations by Gallaway and economist Gary Anderson
of the Joint Economic Committee (JEC) of Congress suggest that the
total cost per worker hired and per hour worked rose particularly
sharply for smaller businesses. (Gary Anderson and Lowell Gallaway,
"Derailing the Small Business Job Express" (Washington, D.C.: Joint
Economic Committee, November 7, 1992), pp. 25-28.) Larger
corporations tend to be less affected (at least directly) by
increases in the minimum wage, since they already pay most if not
all of their workers wages well above the legal minimum. By
contrast, the overwhelming majority of businesses that employ
people at the minimum wage are small and medium-sized.
Consequently, increases in the minimum wage -- like most other
increases in the regulatory burden -- tend to have a greater impact
on smaller firms, and to exacerbate the disparity that already
exists between small and large firms. (For a discussion of the
disparate impact of regulation on small business, and of the
importance of this disparity from the standpoint of job creation,
see pages 10-12 below.)

Private-sector employment peaked in March 1990, and started
declining sharply in April 1990. It appears likely, therefore, that
the legally mandated explosion in the cost of employing relatively
unskilled workers was a significant factor contributing to the
1990- 1991 recession and the stagnation of the past year. (See
chart below.)

Example #2: Federal Labor Laws

Federal labor laws regulate employers' dealings with their
employees and with organized labor unions. Under these laws, the
flexibility of companies to hire and fire workers is restric-ted,
and often they are required to engage in costly negotiations with
labor unions. Far from being balanced, federal labor laws
deliberately tilt the scales in favor of unions and against
employers, as well as against employees who do not wish to join a
union. (See, e.g., Richard A. Epstein, "A Common Law for Labor
Relations: A Critique of the New Deal Labor Legislation," Yale Law
Journal, Vol. 92 (1983), p. 1357; Daniel J. Mitchell, "Government
Intervention in Labor Markets: A Property Rights Perspective,"
Villanova Law Review, Vol. 33, No. 6 (1988), pp. 1043-1057.)

There is, however, no free lunch. Restrictions imposed on
employers (and employees) by federal labor laws inevitably increase
the cost of employing workers, resulting in fewer jobs and lower
wages, or at least in slower growth in employment and wages over
time. (See, e.g., John T. Addison and Barry T. Hirsch, "Union
Effects on Productivity, Profits, and Growth: Has the Long Run
Arrived?" Journal of Labor Economics, Vol. 7 (January 1989), pp.
72-106. In addition, compulsory union dues reduce the net benefits
workers receive for working, thereby reducing the supply of labor
as well as demand.)

Example #3: Mandated Benefits

Regulations that require employers to provide various benefits
to their employees, such as health insurance, unemployment
insurance, workers' compensation, retirement benefits, or child
care, all tend to reduce wages and employment. They increase the
cost of employing workers, which can lead to a slowdown in the
creation of new jobs or even to layoffs.

In the long run, employers will seek to offset their increased
costs, either by reducing wage and salary payments or by cutting
back on other benefits that the employer previously might have
provided voluntarily as a means of attracting workers. As a result,
the total value of the employees' compensation eventually may be no
higher than it would have been in the absence of the regulation. In
fact, the value to the employee may even end up being less than it
would have been, while the cost to the employer may still be
greater. In this case, the regulation will end up reducing the
supply of labor as well as demand. Thus, one way or another, much
of the cost of the regulation will end up being borne by the
workers, whether in the form of fewer jobs, fewer fringe benefits,
a reduction in the growth of wages over time, or some combination
of the three. (See, e.g., Richard B. McKenzie, The American Job
Machine (New York: Universe Books, 1988), pp. 218-31; Don Bellante
and Philip K. Porter, "A Subjectivist Economic Analysis of
Government-Mandated Employee Benefits," Harvard Journal of Law and
Public Policy, Vol. 13, No. 2 (Spring 1990), pp. 657-687.)

Regulation and Small Business

The U.S. economy created some 19 million net new private-sector
jobs during the 1980s. Most of these new jobs were created by new
businesses, and most of the remainder were created by existing
small businesses. (Lawrence A. Kudlow, "Small Business Is Big
Business," Global Spectator, February 28, 1992, reprinted in
Congressional Record, March 10, 1992, p. S3153.) By contrast, large
U.S. multinational corporations contributed less than one-tenth of
one percent of the employment growth that occurred between 1982 and
1989. (Ibid.) Indeed, employment by Fortune 500 corporations
actually fell by about 4 million jobs during the 1980s. (George F.
Will, "A refresher course on what ails us," The Providence
Journal-Bulletin, September 14, 1992, p. A6.) Thus, taken as a
separate sector, employment in small and medium-sized businesses
actually grew by an astounding 23 million jobs.

Small businesses have always been the engine of job creation in
the U.S. economy. Some 57.2 percent of all net new jobs created
between 1976 and 1986 were created by firms with fewer than 500
employees, 43.7 percent were created by firms with fewer than 100
employees, and 26.2 percent were created by firms with fewer than
20 employees. (U.S. Small Business Administration, The State of
Small Business: A Report of the President (Washington, D.C.: U.S.
Government Printing Office, 1989), p. 48.) Today, two out of every
three new jobs in the United States are created by small and
medium- sized businesses. (Kudlow, op. cit.) The vast majority of
American businesses are small, and the majority of American workers
are employed by small firms. In the U.S., 93.3 percent of all
business establishments employ fewer than 100 employees, and 83.4
percent employ fewer than 20 employees. Only 3.4 percent of all
firms employ 500 or more employees, and only 1.5 percent of all
firms employ 5,000 or more employees. (David L. Birch, Job Creation
in America: How Our Smallest Companies Put the Most People to Work
(New York: The Free Press, 1987), p. 9.)

How Regulation Hurts Small Business

Regulation does not affect all businesses equally. It imposes
the heaviest burdens on small and medium-sized businesses. The
reason is that small and medium-sized firms find it harder to
spread the high overhead costs of processing paperwork, attorney
and accountant fees, and the staff time needed to negotiate the
federal regulatory maze. Direct labor regulations, such as
increases in the minimum wage, also represent a comparatively
larger burden for small firms. Consequently, increasing levels of
regulation tend to put small and medium-sized businesses at a
competitive cost disadvantage compared with larger firms. (See,
e.g., Ann P. Bartel and Lacy Glenn Thomas, "Direct and Indirect
Effects of Regulation: A New Look at OSHA's Impact," Journal of Law
and Economics, Vol. 28, No. 1 (April 1985), pp. 1-25; Ann P. Bartel
and Lacy Glenn Thomas, "Predation Through Regulation: The Wage and
Profit Effects of the Occupational Safety and Health Administration
and the Environmental Protection Agency," Journal of Law and
Economics, Vol. 30, No. 2 (October 1987), pp. 239-264; B. Peter
Pashigian, "The Effects of Regulation on Optimal Plant Size and
Factor Shares," Journal of Law and Economics, Vol. 27, No. 1 (April
1984), pp. 1-28; B. Peter Pashigian, "Environmental Regulation:
Whose Self Interests Are Being Protected?" Economic Inquiry, Vol.
23, No. 4 (October 1985), pp. 551-584.)

Future regulation will compound this problem. For example,
although President Clinton has yet to finalize his health care
proposals, he has indicated tentative support for proposals to
require firms to shoulder much of the cost of universal coverage
for workers and their families. This would significantly increase
the cost of hiring workers in the small business sector, where many
firms currently do not provide coverage. While 98 percent of all
firms with 100 or more employees already provide health benefits,
only 27 percent of firms with fewer than 10 employees offer health
benefits at present. (Health Insurance Association of America,
Source Book of Health Insurance Data 1991 (Washington, D.C.: Health
Insurance Association of America, 1991), p. 27 (Table 2.5).) In
other words, while 73 percent of firms with fewer than 10 employees
would see their cost of employing workers rise under either of
these proposals, only 2 percent of firms with 100 or more employees
would be significantly affected.

Out of the Frying Pan and into the FireTo its credit, Congress generally has tried to compensate
for the disproportionate burden of regulation on smaller firms by
exempting firms below a certain size -- measured by the number of
employees -- from various regulations. For example, the Worker
Adjustment and Retraining Notification Act of 1988, which requires
employers to give employees and local government officials advance
notice before closing a plant or laying off workers, only applies
to firms with 100 or more employees. Likewise, the Americans with
Disabilities Act (ADA) of 1990 currently applies only to firms with
25 or more employees. After July 26, 1994, however, the ADA will
apply to firms with 15 or more employees.

Unfortunately, this well-intentioned approach does not really
solve the problem; it merely changes the form of the problem. In
some respects it may even make the problem worse, for it gives
businesses an incentive not to grow beyond a certain size. If a
firm stays small enough, it remains exempt from regulations.
However, if it hires "too many" workers, it becomes subject to
various costly regulations. Thus, instead of punishing firms merely
for being small, federal regulations also punish small firms for
growing and creating more jobs.

As a result, firms nearing the relevant threshold for a rule
have a powerful incentive to avoid hiring additional employees. For
example, in a letter to The Washington Times, the president of
Schonstedt Instrument Company of Reston, Virginia, tells how he has
deliberately kept his company below 50 employees in order to avoid
having to file certain forms with the federal government, because
of the cost and time involved. (E.O. Schonstedt, letter to the
editors, The Washington Times, February 16, 1992, p. B5.)

Worse still, the prospect of an exemption from a regulation can
make it profitable for firms actually to reduce their workforces in
order to fall below the relevant threshold. For example, the Family
and Medical Leave Act of 1993, recently signed into law by
President Clinton, will apply to firms with 50 or more employees.
Calculations by the Joint Economic Committee (JEC) of Congress
suggest that under this law, a firm whose optimal size before the
regulation was 60 employees might actually find it profitable to
cut back to 49 employees. (Anderson and Gallaway, op. cit., pp.
21-24.) As the JEC report puts it, "Exemption from government
regulations and mandates on the basis of the size of a company is a
guaranteed recipe for making small businesses smaller." (Ibid., p.
24.)

The Myth that Regulation Creates Jobs

Defenders of regulation sometimes argue that while regulation
may cut jobs in some firms, in general it is good for the economy
and creates jobs. A number of writers recently have made this
argument in connection with environmental regulation. (E.g.,
Timothy E. Wirth, "Easy Being Green... Lighten Up, Loggers --
Environmentalism Actually Creates Jobs," The Washington Post,
October 4, 1992, p. C3; Michael Silverstein, "Bush's Polluter
Protectionism Isn't Pro-Business," The Wall Street Journal, May 28,
1992, p. A21; Curtis Moore, "Bush's Nonsense on Jobs and the
Environment," The New York Times, September 25, 1992, p. A33.) For
example, it is pointed out that environmental regulations stimulate
employment in industries that manufacture special devices required
by government, such as scrubbers for smokestacks, and create jobs
in environmental clean-up firms. Similarly, it is argued that
securities regulations and the Treasury's regulations interpreting
the Internal Revenue Code create employment for lawyers and
accountants.

These arguments almost always rest on a basic economic fallacy:
they confuse the creation of jobs in a particular industry with the
creation of jobs for the economy as a whole. Thus while jobs are
indeed created in firms that assist in helping companies comply
with rules, these rules also cost jobs in the regulated industry.
The fallacy that adding costs to firms actually creates jobs in the
economy is a persistent fallacy that was refuted decades ago.
Rather than creating jobs, regulation simply diverts employment
from productive to unproductive activities, with a net loss in
efficiency and jobs. (See Frederic Bastiat, "What Is Seen and What
Is Not Seen," in Frederic Bastiat, Selected Essays on Political
Econ- omy, trans. Seymour Cain, ed. George B. de Huszar
(Irvington-on-Hudson, New York: Foundation for Economic Education,
1964); Henry Hazlitt, Economics in One Lesson (Westport,
Connecticut: Arlington House, 1979).) .In particular instances, the
jobs created may be more or less numerous than those destroyed. For
example, if a new Medicare regulation increases the cost of doing
brain surgery, a hospital may lay off one $300,000-per-year brain
surgeon and hire three $30,000- per-year administrators to fill in
the relevant Medicare forms. In other instances, however, a firm
may lay off three blue-collar workers and replace them with one
higher-paid engineer. There is no reason to expect the jobs that
are created because of regulation to systematically outnumber -- or
pay more than -- the jobs that are destroyed.

How to Avoid Unnecessary Job Losses

Jobs are lost unnecessarily though regulation because currently
there is no explicit requirement that the employment effects of
regulation be considered, either by Congress when it legislates or
by federal regulatory agencies in the rule-making and enforcement
process.

Executive Order (EO) 12291, issued by President Reagan in
February 1981, does require executive branch agencies to inquire
into the overall costs and benefits of proposed regulations.
However, EO 12291 does not explicitly require any particular kind
of costs or benefits to be counted. Thus, while the negative
effects of a proposed regulation on wages or employment levels can
be counted as costs, they do not have to be. Likewise, the
employment-enhancing effects (if any) of a proposed regulation can
be counted as benefits, but need not be. An agency thus may compute
benefits and costs in dollars without ever counting how many jobs
would be gained or lost. Moreover, EO 12291 applies only to new
regulations, not regulations that are already on the books. And EO
12291 does not apply to any of the "independent" regulatory
agencies that lie outside the executive branch, such as the
Securities and Exchange Commission or the Federal Communications
Commission.

This is not merely a problem in theory. A recent study by the
National Commission for Employment Policy examined the regulatory
review practices of seven federal agencies with major
responsibility for preparing and enforcing regulation. The study
found that "federal regulatory agencies . . . do not explicitly or
systematically take potential employment effects into consideration
during the review process, or in enforcement decisions." (Nancy A.
Bord, "Addressing Employment Effects in the Regulatory Review
Process," draft final report prepared for the National Commission
for Employment Policy, September 9, 1992, p. 33.) Even when
employment effects are considered by the agencies, they are
considered either in a simplistic way, or on the basis of faulty
assumptions and models. The methodologies used vary from agency to
agency, and even from regulation to regulation within agencies. The
study also found that federal regulatory agencies generally fail to
consider the cumulative effects of existing regulations and the
possible effects of new regulations on existing rules.

Because regulation of one part of the economy can affect other
parts, and because regulations often interact with each other in
significant ways, no regulation can properly be judged or measured
in isolation. (An analogous point applies in the area of taxation:
Because different taxes often interact with each other in important
ways, no individual tax can properly be evaluated in isolation. In
fact, strictly speaking, taxes and regulations can only be analyzed
in conjunction with each other. Each specific tax must be analyzed
in light of every other tax and every regulation, and each specific
regulation must be analyzed in light of every other regulation and
every tax. See generally John R. Hicks, Value and Capital, 2nd ed.
(Oxford: Oxford University Press, 1946); Arnold C. Harberger,
Taxation and Welfare (Chicago: University of Chicago Press, 1974).)
In fact, this interaction means the adoption of a new regulation
can increase the cost imposed by existing regulations. Therefore,
computing the total costs and benefits of any new regulation would
require determination of the net impact of all regulations taken
together. Generally speaking, the greater the volume of regulation
that already exists when a new regulation is introduced, the
greater will be the incremental, overall cost of adding the new
regulation. Failure to take account of this is one of the most
important factors contributing to the enormous growth in the
overall regulatory burden. It also helps explain the decline in
U.S. labor productivity and wage growth over the past two decades
(see chart on following page), and the decline in employment during
the last two years.

In light of the severe burden imposed by regulation on
employment, President Clinton and Congress should reform the
regulatory review process. Among the necessary reforms:

Reform #1: President Clinton should issue an executive order
requiring explicit consideration of the employment effects of all
new regulations.

Reform #2: Congress should extend the same requirements to all
of the "independent" regulatory agencies that lie outside the
executive branch.

Reform #3: The President and Congress should establish a federal
regulatory budget.

Under a regulatory budget, a limit would be placed on the total
estimated cost imposed on the economy each year by all federal
regulations. This limit would apply to new and existing regulations
taken together. Thus, if the budget had been reached, an agency
wishing to add a new regulation would have to repeal or modify an
existing regulation. If an agency could not find a large enough
offsetting reduction among the other regulations for which it was
responsible, the government would have to agree to an offsetting
reduction by another agency.

The introduction of a regulatory budget would have several
virtues. First, it would place a limit on the total cost that can
be imposed on the economy by federal regulation. This total burden
would have to be a political decision, with ordinary Americans able
to take part in the national discussion.

Second, it would force agencies to debate each other to justify
the merits of proposed regulations, with the Office of Management
and Budget (or any other body designated by the President, such as
the newly created National Economic Council) making the final call.
This in turn would compel the agencies, as they are not compelled
at present, to think seriously about which regulations are most
important to them and yield the greatest benefits.

And third, it would give agencies the incentive to review their
existing regulations and find those which are not really worth
retaining -- or are causing greater job losses than expected -- in
order to make room for new regulations with a higher priority.

Reform #4: Congress should require the expected employment
effects of all proposed regulations to be published in the Federal
Register before the regulations take effect.

Present law allows but does not require publication of expected
employment effects in the Federal Register. Congress should make
such disclosure mandatory. In the meantime, executive and
independent agencies should disclose expected job losses or wage
reductions voluntarily.This would permit the public to know the
expected magnitude of any job losses or net wage reductions. Thus
Americans could comment on this aspect of proposed regulations
before they take effect. This also would enable the public to
compare actual job losses with what was predicted at the time each
regulation was issued.

Conclusion

The President and Congress must do something to get the problem
of growing federal regulation under control. Regulation at the
federal, state, and local levels is now costing the American people
somewhere between $810 billion and $1.7 trillion per year, even
after taking account of benefits, or between $8,400 and $17,100 per
year per household. A major portion of this cost consists of the
output that the American economy could have been producing today
but is not because of over twenty years of excessive and
inefficient regulation -- somewhere between $450 billion and $1.1
trillion per year.

Another important cost of regulation is the failure to create
more employment opportunities for Americans who would like to work.
Many regulations directly increase the cost of employing workers
and therefore act just like a hidden tax on job creation and
employment. Unfortunately, regulation places especially heavy
burdens on smaller and medium-sized businesses, which are the
primary engines of job creation. As a consequence, there probably
are at least three million fewer private-sector jobs in the
American economy than could have existed today if the growth of
regulation had been controlled and regulations had been more
sensibly and efficiently designed.

While regulation has been taking a toll on employment throughout
the last two decades, the toll has risen sharply in just the last
four years. Moreover, two of the most significant and costly new
regulations of the last four years -- the 1990 Clean Air Act
Amendments and Americans with Disabilities Act (ADA) -- only
started to take effect a few months ago; some of their provisions
will not take effect until the middle of 1994. So the impact of
these regulations on employment still lies in the future -- the
heavy job losses due to regulation in the last three years have
been caused by existing rules. In other words, the employment loss
due to regulation is almost certain to get worse if the President
and Congress do not take action.

Many specific federal regulatory programs deserve a drastic
overhaul. Even though repeal of such new regulatory programs as the
Clean Air Act Amendments and the ADA is politically unlikely, the
President and Congress could act to lighten the overall regulatory
burden in other areas. Reform of deposit insurance and federal
banking laws, for example, could help the entire economy and would
do much to alleviate the credit crunch that has restrained job
creation by small and medium-sized businesses over the past three
years. (See William G. Laffer III, "How to Reform America's Banking
System," Heritage Foundation Backgrounder No. 810, February 26,
1991; Victor A. Canto, "The Credit Crunch" (La Jolla, California:
A.B. Laffer, V.A. Canto & Associates, April 20, 1990); Victor
A. Canto, "The Credit Crunch Revisited" (La Jolla, California: A.B.
Laffer, V.A. Canto & Associates, November 16, 1990); William C.
Dunkelberg and William J. Dennis, Jr., "The Small Business Credit
Crunch" (Washington, D.C.: NFIB Foundation, December 1992); Paul
Craig Roberts, "Economic Dominoes," National Review, November 30,
1992, pp. 37-42. As predicted by Canto and confirmed by Dunkelberg
and Dennis, the credit crunch has mainly affected medium-sized
businesses and larger small businesses (that is, those small
businesses with at least 40 employees).)

But besides dealing with specific regulations, the regulatory
process itself is badly in need of reform. What is needed is for
the President and Congress to force agencies to inform Americans of
the likely employment effects of proposed rules and to set
priorities in rule-making. If these reforms are instituted, the
federal government's regulation of the economy could be conducted
with the fewest pink slips for American workers.